Diversification losing sheen on Dalal Street this year

The investment rule of spreading your eggs over diverse baskets doesn't seem to be working on Dalal Street this year.

In the current year, bigger and more diversified indices have grossly under-performed the smaller and less diversified ones. In fact, the losses have increased with a rise in portfolio diversification.

The 30-stock BSE Sensex has been the best performing index in the current year, followed by the 50-stock Nifty of the National Stock Exchange. The BSE 500, the most broad-based, has been the biggest loser.

In the year to date, the BSE Sensex has lost just one per cent of its value, while the Nifty is down nearly four per cent. The BSE 500 has lost nearly 10 per cent of value since the start of the year (see chart).

In the past, all major benchmark indices moved together. And, generally, the broader indices did better than the more focused ones such as the BSE Sensex. In 2012, for instance, the BSE 500 was the best performing, rising 22.6 per cent against the Nifty's 20.3 per cent rise and the 19 per cent return delivered by the Sensex during the year.

Investors, say analysts, are trying to conserve capital rather than juice-up their earnings. "The macro economic uncertainty has made investors extremely cautious and they have become choosy about the stocks they like. This has gone against potentially high growth but riskier bets such as the banking, financial and rate-sensitive sectors," says Sandeep Gupta head of equity advisory at Motilal Oswal Securities.

The money has moved to financially conservative companies or those most insulated from the current turmoil, such as information technology, health care and fast moving consumer goods.

This has impacted the key indices, as no two of these have a similar sector composition. "An index performance is ultimately a sum of movement in its key constituent stocks and there has been a wide divergence in the sectoral performance this year," says G Chokkalingam, chief investment officer at Centrum Wealth Management. This is the key reason why the Nifty, the most popular index among derivative traders, has underperformed the Sensex in the current year. "The Nifty has higher representation from cyclicals and rate-sensitives such as banks, financials and infrastructure than the Sensex," he says.

Broader indices such as the BSE 100 and the BSE 500 suffered due to the poor show by mid-caps and small-caps. "The market is being currently driven by foreign institutional investors and having burnt their fingers in mid-caps and small-caps in the past, they now only favour large-cap stocks. This, coupled with a lack of domestic participation, has nearly dried the demand for mid-cap stocks," says Chokkalingam.

This hurts the broader indices, as there are at best just a handful of blue-chip large-cap stocks with the potential to weather the current macro economic turmoil.

Some see an opportunity in this. "The pain in the broader market is much more severe than what the Sensex or the Nifty captures. Many quality mid-caps are now available at a deep discount to their larger peers. This is the time for stock pickers and those who believe in active portfolio management," says Gupta.

Diversification still works but only if investors are agile enough to change their portfolio mix in line with the change in market dynamics. This demands more time and effort than they have been used to in the past decade.